Bear of the Day – Genomic Health (GHDX)

The earnings outlook for GDHX was cut in half this summer

Genomic Health (GHDX) is a life science company focused on the development and commercialization of genomic-based clinical diagnostic tests for cancer that allow physicians and patients to make individualized treatment decisions. It was started in 2000 by CEO Randy Scott, who was then at Incyte Genomics (INCY).

Randy Scott’s experience with a close friend who was diagnosed with cancer brought him the realization that despite all the research to map and understand the human genome, there was little being done to help patients get the best care based on the molecular make-up of their specific tumor.

Scott set out with the goal of developing high-value diagnostics to enable more personalized cancer treatment decisions driven by the genomic activity within a patient’s individual tumor.

In 2004, the company launched its first test, Oncotype DX, which has been shown to predict the likelihood of breast cancer recurrence and chemotherapy benefit in early stage breast cancer patients. The Oncotype DX assay represents the first diagnostic gene expression test on the market that provides consistent results across multiple independent trials having breast cancer patients, including a large validation study of The New England Journal of Medicine.

Earnings Outlook Cut in Half

The reason that Genomic’s shares have been hanging out amidst the Zacks #5 Rank stocks (Strong Sell) is that their earnings outlook significantly deteriorated after a Q2 earnings miss at the end of July. On August 1, the stock dropped to a #5 and has since traded down over 15% from $36 to $30.

Genomic reported a second-quarter 2013 net loss of $3.0 million, down from net income of $1.8 million in the year-ago period. The 10-cent per share loss was down from the year-ago period’s earnings of 6 cents per share. The dismal performance was primarily attributable to a huge contraction in bottom line.

However, total revenue (comprising solely of product revenues in this quarter) climbed 10.5% year over year to $63.7 million, almost in line with the Zacks Consensus Estimate. The upside was driven by an 11% increase in product revenues and 9% growth in tests delivered.

The improvement in product sales was mainly on the back of a significant increase in invasive breast cancer penetration in the U.S. Continued international expansion was another major upside. During the reported quarter, international product revenues grew 58% year over year to $9.2 million and international test volume increased 43%.

Genomic provided 20,640 Oncotype DX test results, up 9% year over year. And despite the completion of a collaboration with Pfizer (PFE) in the last quarter, the company failed to generate contract revenues in the reported quarter.

After this report, analysts took 2014 EPS estimates down from $0.27 to $0.13.

Challenges to Growth

Genomic’s science is definitely exciting in its ability to help patients and their physicians determine better treatments, and it was recently confirmed that the company will be launching a prostate cancer product next year. But analysts are not very excited right now about the earnings front, especially given the company’s dominant market share already in breast cancer diagnostics.

According to Raymond James analysts, who downgraded GHDX to Underperform last month, “While we model mid-single digit top-line growth in base U.S. breast cancer, the market is already 60% penetrated and Genomic Health has more than 90% market share, making outsized gains going forward unlikely. Additionally, Agendia continues to make a modest amount of noise with their MammaPrint test and the recent FDA-approval of NanoString’s Prosigna Breast Cancer Prognostic Gene Signature Assay also adds another market entrant in 2014, adding the potential for slight share erosion over time.”

Unless a positive fundamental catalyst surfaces, this stock could be on its way to test 52-week lows under $26. Investors should exercise caution and wait for a turn-around in the estimates before establishing new positions.

Kevin Cook is a Senior Stock Strategist for Zacks where he runs the Follow The Money portfolio.